Remember $4 gasoline? Oil speculators are back

Despite weak demand in the U.S. and Europe, oil prices climbed this week to near $90 a barrel and gasoline prices have passed $3 a gallon on the West Coast and parts of the Northeast. Wall Street speculators are driving up oil and gasoline prices again — just in time to dampen holiday cheer.

WASHINGTON — Despite weak demand in the U.S. and Europe, oil prices climbed this week to near $90 a barrel and gasoline prices have passed $3 a gallon on the West Coast and parts of the Northeast.

Why? If demand is down and supplies are plentiful — and they are — why would prices be going up?

Because Wall Street speculators are driving up oil and gasoline prices again — just in time to dampen holiday cheer.

"It's all about investor optimism, and that's been the story about 2010 ... that's the primary reason why we're seeing oil prices at $90 (a barrel) and gasoline making an uncharacteristic climb in December towards $3 a gallon," said Troy Green, a national spokesman for the AAA Motor Club, which monitors gasoline prices.

AAA's Fuel Gauge Report shows the nationwide average for a gallon of regular unleaded gasoline stood at $2.968 on Wednesday. That's up 11 cents a gallon from a month ago and 33 cents a gallon over one year ago. That means it costs about $1.65 more per fill-up than a month ago and $4.95 more than a year ago.

It's even worse on the West Coast, where this week prices have averaged higher than $3.15 a gallon, according to Energy Department data.

If oil prices keep climbing beyond $100 per barrel, as Goldman Sachs projects for 2011, higher fuel prices may blunt efforts by the Obama administration and the Federal Reserve to stimulate the weak economy.

"I think we're at that point. With (nearly) 10 percent unemployment, it's a much more impoverished consumer that can't afford it. It's almost a bludgeoning instrument in terms of what it will do to consumer sentiment," said John Kilduff, a veteran energy analyst and partner in the hedge fund Again Capital. "What might have been a very bright shopping season could get the wind taken out of its sails by these high prices."

Rising prices could erase the stimulus coming from the 2 percentage point reduction in payroll taxes proposed this week by President Barack Obama and Republican congressional leaders. This would hit the working poor particularly hard.

"The money they get from government tax relief, they'll have to go pay in higher prices for food and energy," said Michael Masters, head of Masters Capital Management and a frequent witness before Congress about financial speculation in oil contracts.

The Energy Information Administration, the statistical arm of the Energy Department, said Wednesday that there is, in fact, increasing demand for oil compared with last year's low demand amid the recession.

But supplies are abundant, it said in its weekly report, This Week in Petroleum — especially when compared with a few years ago.

Economic growth in emerging markets and China has raised global demand for oil, the EIA said, while U.S. demand for oil year-over-year grew by 750,000 barrels per day in August and 900,000 in September. The numbers, it said, are of "an order approaching, or even exceeding, growth levels seen in China."

However, the EIA cautioned that "even given strong growth this year, U.S. oil demand remains well below peak levels seen in 2005, and recent growth rates relative to year-ago levels are not expected to continue."

There's been so much oil in storage on land this year that oil tankers were actually converted into floating storage facilities.

"Those (oil inventory) numbers were extremely high two months ago, but pretty much the majority of that floating storage has been liquidated," said Joe Poscillico, an account executive at MF Global. "The inventories on land are starting to decrease week by week and getting more toward average numbers."

Another explanation for falling inventories, one that belies the justification for higher prices, is that refiners who convert oil into gasoline are operating at extremely low utilization rates. They were operating at 86 percent of their capacity on average during the first nine months of the year.

That's higher than last year's average of 82.9 percent but well below the late 1990s and a period from 2000 to 2006, when refiners operated at well over 90 percent of their installed capacity to make gasoline.

Lower production runs create tightened supplies, which in turn drives up prices and sets the table for speculators.

"I really don't remember a period where we've had refinery run rates so low for this long," said Kilduff, who likened the low production to "draining the swamp."

"Financial physics" is again behind high prices, he warned, adding that crude oil "represents a store of value, the way gold and some other commodities do."

The Federal Reserve is also driving investment into oil contracts, Kilduff said, because of its moves to force investors out of the safe haven of government bonds and into risk taking — a process called quantitative easing.

That's a view shared by Masters, who thinks that "financial flows are the primary reason why you are getting increases in prices, because investors are trying to 'hedge,' because of quantitative easing and who knows what else," Masters said. "They've decided that they want to own crude and other commodities anyway because they just want to own them."